9.401 Auditing

Chapter 6Chapter 6

Audit EvidenceAudit Evidence

What is Audit Evidence?

=Any information =Any information used by the auditor used by the auditor to draw conclusions regarding to draw conclusions regarding whether the information being audited is whether the information being audited is

stated in accordance with the established stated in accordance with the established criterioncriterion

• Must be Must be sufficient sufficient and and appropriate appropriate at lowest at lowest possible costpossible cost

Audit evidence decisions

NatureNature What type of procedure to use and what What type of procedure to use and what

evidence to gatherevidence to gather TimingTiming

When evidence is gathered and covering When evidence is gathered and covering what time periodwhat time period

Extent Extent How many items to test and which items How many items to test and which items

to selectto select

Sufficient and Appropriate Evidence

Sufficiency:Sufficiency:• Refers to quantityRefers to quantity• ““Extent” evidence Extent” evidence

decisiondecision• Depends on Depends on

expectations of expectations of errors, quality of errors, quality of controls, size of controls, size of popn, materiality, popn, materiality, level of assurance, level of assurance, etc.etc.

AppropriatenessAppropriateness• Refers to qualityRefers to quality• ““Nature” and Nature” and

“Timing” evidence “Timing” evidence decisionsdecisions

• Depends on level of Depends on level of assurance neededassurance needed

• If evidence is not If evidence is not appropriate, appropriate, sufficiency won’t sufficiency won’t help.help.

To be appropriate… RelevanceRelevance

= addresses the objective or assertion= addresses the objective or assertionEg. Existence vs. completenessEg. Existence vs. completeness

Auditor’s direct knowledge vs. otherwiseAuditor’s direct knowledge vs. otherwise Examination, observation, inspection or Examination, observation, inspection or

computation by auditor > someone elsecomputation by auditor > someone else Independence of providerIndependence of provider

Provider external to org > external to Provider external to org > external to acctg dept > acctg deptacctg dept > acctg dept

Documents external to org > external Documents external to org > external docs held by org > internal docsdocs held by org > internal docs

To be appropriate… Effectiveness of Internal controlsEffectiveness of Internal controls

Evidence from system of good I.C. > Evidence from system of good I.C. > evidence from system of poor I.C.evidence from system of poor I.C.

Qualifications of individuals providing the Qualifications of individuals providing the informationinformation

Degree of objectivity of evidence (vs. Degree of objectivity of evidence (vs. subjectivity)subjectivity)

Timing Auditor must express conclusion on information at Auditor must express conclusion on information at

balance sheet date.balance sheet date. However, may gather information as at non-However, may gather information as at non-

balance sheet date and “roll forward” the balance sheet date and “roll forward” the conclusion by:conclusion by: Substantive testsSubstantive tests Relying on internal controlsRelying on internal controls Other proceduresOther procedures

To do this, consider To do this, consider quality of internal controls, quality of internal controls, materiality of item and materiality of item and level of risk associated with itemlevel of risk associated with item

Types of Evidence1)1) Physical ExaminationPhysical Examination

• = inspection or count of tangible assets= inspection or count of tangible assets• Good evidence of existence, but not at all of Good evidence of existence, but not at all of

ownership and not really of valuationownership and not really of valuation2)2) ConfirmationConfirmation

• = receipt of response from 3= receipt of response from 3rdrd party verifying party verifying accuracy of info requested by auditoraccuracy of info requested by auditor

• Costly, but reliable evidence of existenceCostly, but reliable evidence of existence• Usually required for A/R except in certain Usually required for A/R except in certain

circumstancescircumstances• Used for many other accounts as wellUsed for many other accounts as well• Must be kept under control of auditorMust be kept under control of auditor

Types of Evidence3)3) DocumentationDocumentation

• = inspection of documents and records= inspection of documents and records• Quality depends on quality of document Quality depends on quality of document

(external vs. internal, internal control)(external vs. internal, internal control)• If electronic, auditors must assess controls If electronic, auditors must assess controls

over changes to documentsover changes to documents

4)4) ObservationObservation• = watching certain activities= watching certain activities• Generally needs corroboration for assurance Generally needs corroboration for assurance

that conditions persist that conditions persist

Types of Evidence5)5) Inquiries of ClientInquiries of Client

• = written or oral representations of client in = written or oral representations of client in response to auditor’s request for informationresponse to auditor’s request for information

• Generally not conclusive, should be Generally not conclusive, should be corroborated when possiblecorroborated when possible

• Underlines importance of mgmt good faith, Underlines importance of mgmt good faith, care must be taken in choosing clientscare must be taken in choosing clients

6)6) ReperformanceReperformance• = auditor rechecking computations or other = auditor rechecking computations or other

operations done by clientoperations done by client• Particularly often used when testing controls Particularly often used when testing controls

7. Analytical Procedures

= using financial and non financial data in = using financial and non financial data in meaningful comparisons and relationships meaningful comparisons and relationships to determine whether account balance is to determine whether account balance is reasonablereasonable

Can be quite effective at low costCan be quite effective at low cost Reliability depends on quality of data, Reliability depends on quality of data,

nature of analysis, skill of auditor, level of nature of analysis, skill of auditor, level of detaildetail

Purposes of Analytical Tests

As audit evidence which enables the As audit evidence which enables the reduction of audit testing of details.reduction of audit testing of details.

Indication of errors in the statements Indication of errors in the statements requiring follow-up.requiring follow-up.

Indication of financial difficulty.Indication of financial difficulty. Understanding the client’s business and Understanding the client’s business and

industry.industry. An aid to management.An aid to management.

When Analytical procedures are used:

MUST be used in:MUST be used in: planningplanning final reviewfinal review

MAY be used as a substantive testMAY be used as a substantive test

Analytical Procedures Comparison of Current year balances to:Comparison of Current year balances to:

balances for one or more comparable periods.balances for one or more comparable periods. company’s budgets and forecasts.company’s budgets and forecasts. other current-year balances for conformity with other current-year balances for conformity with

predictable patterns based on the company’s predictable patterns based on the company’s experience.experience.

similar information for the industry in which the similar information for the industry in which the company operates.company operates.

relevant non-financial information.relevant non-financial information.

Analysis of Un-audited Financial Statements

Horizontal analysisHorizontal analysis examines changes of FS numbers examines changes of FS numbers and ratios across two or more yearsand ratios across two or more years

Vertical analysisVertical analysis examines FS amounts expressed each examines FS amounts expressed each year as proportions of a base.year as proportions of a base.

Auditors look for relationships in accounts as indicators Auditors look for relationships in accounts as indicators of problems and to plan further audit workof problems and to plan further audit work

Problems discovered by analytical procedures

Account balances that seem high could indicate Account balances that seem high could indicate problems with:problems with: existenceexistence valuationvaluation ownershipownership

Account balances that seem low could indicate Account balances that seem low could indicate problems with:problems with: completenesscompleteness valuationvaluation

Conclusions from analytical procedures Don’t indicate definitively that there is an Don’t indicate definitively that there is an

error. Unexpected fluctuations may be from error. Unexpected fluctuations may be from error or non-error causes.error or non-error causes.

Client explanations should be corroborated Client explanations should be corroborated if they relate to a material item.if they relate to a material item.